Over the last few years there has been a virtual epidemic of property managers who have taken their clients' money, and up until now, there has been little recourse. If the local police department and the county state's attorneys office can be motivated to prosecute, then there may be a possibility of a recovery of the money and punishment of the culprit.
Frequently, the police and/or the state's attorney will respond that "it is a civil matter" and refuse to investigate a complaint.
An aggrieved board can then try and lodge a claim with the manager's insurance company but too many boards have not been diligent in making sure that the manager had insurance, and that only leaves the association's own insurance company to seek recourse.
Again, it is a question of coverage and since most board's are probably not aware of whether this risk is even covered, it could leave the association stranded with no money and no bad guy to pursue.
(This is not a reflection on the thousands of honest and hardworking property managers whose reputations are tarnished by this type of conduct.)
In a recent column, I wrote about the forthcoming legislation effective Jan. 1, 2010, which licenses and regulates property managers.
It is hoped that these new laws will deter anyone in the future from preying on an innocent association, but it will take a while for all of the details of this new system to become reality.
In the end, it is the unit owners who will ultimately pay, either through replacing the funds that have been lost forever, or through higher insurance premiums. Sometimes, even a conscientious board of directors can be caught off guard, but many times, the board was totally trusting, failed to have an annual audit, had no checks and balances in place, and was not diligent.
The question then arises; do the aggrieved owners have recourse against a negligent board for losses suffered from a dishonest manager's misappropriation of their funds which cannot be recovered?
A derivative action is a type of lawsuit that is typically associated with corporations. A shareholder will file a suit on behalf of the corporation (for the shareholders indirectly) against a board and management for malfeasance, acts of dishonesty, mismanagement, fraud, etc.
As a result of a recent Illinois Appellate Court decision condominium unit owners were found to have standing to sue an association's former directors for breach of fiduciary duty after the property manager embezzled funds (Davis v. Dyson 387 Ill. App. 3rd 676 2008).
The plaintiff unit owners alleged that the board received financial statements between 1998 and 2003, and never reviewed them, including bank statements where checks had actually been forged.
The board never ordered an independent review or audit! They also failed to make sure they had adequate insurance coverage to protect association funds.
When the current board refused to investigate the conduct of the past board members who presided while these actions took place, it was alleged that the current board members violated the business judgment rule. (A board is held to this standard which is to use sound business judgment in all of its business dealings; one of the components of fiduciary duty.)
The Appellate Court ruled that a derivative lawsuit is one of the remedies for corporate mismanagement, through fraud, neglect of duty or declines to take proper action to protect the corporation.
The shareholders (unit owners) have standing to bring an action against third parties who wrong the corporation.
This is a landmark case as it opens up an entire area of exposure for directors while simultaneously emboldening owners to pursue their rights when a legitimate grievance is ignored.
Too many people are elected to the board with no understanding of the job or the expectations of unit owners who want to see the board run the association like a business.
Many directors do not want to spend the money it takes to be diligent, relying upon dumb luck in not getting sued.
The risks have now been increased substantially and "penny wise, and dollar foolish" is more relevant than ever.
Volunteers who come together who are willing to put in the time to protect everyone's property values have now had their potential exposure to suit increased.
However, it is not my intention to discourage or scare people from serving on the board, but rather by following some basic rules the board not only will not get sued, but if it should, it will have a bona fide defense while at the same time protecting all their fellow owners from the types of directors who will not be conscientious and expose the owners to further risk of loss.
Here is a simple checklist on how to avoid the types of risks that put the board of the association in Davis, e. al. in jeopardy:
•Do an annual audit or independent financial review. No exceptions.
•Have your insurance program reviewed every year to make sure you are adequately covered and use an agent with experience in condominium law.
•Do not get legal advice from your property manager, accountant, an attorney who lives in the condominium or anyone else other than your own counsel who has expertise in condominium law and with whom you have an ongoing relationship.
•Make sure there are checks and balances on the issuance of all checks and withdrawals or transfer of association funds. If the board members do not have the time, hire people who are licensed and insured.
•If you have substantial funds on deposit, hire a professional money manager to advise the board on how to invest the money in safe, sound protected investment accounts.
•Meet your banker, know them by name and have a periodic dialogue rather than just looking at numbers on paper.
There are many other procedures to put into place, but surprisingly, many associations do not even follow these basic rules.
As the economy continues to tighten and associations find themselves in financial constraints, by implementing some simple oversight, a board will not be faced with an ownership in upheaval looking at the board members as a target to make them whole.
• Jordan Shifrin is an attorney with Kovitz Shifrin Nesbit in Buffalo Grove. Send questions for the column to him at firstname.lastname@example.org. This column is not a substitute for consultation with legal counsel. Past columns can be read at www.ksnlaw.net.